Low Risk Bonds

Low risk bonds are referred to as those having very low or nil risk of defaulting on interest rate or principal payments. These bonds are also referred to as ‘investment-grade bonds’. Low risk bonds in India are usually issued by governments, highly rated corporates & municipal bodies. In this article, we explain types and benefits of low risk bonds, tax efficient low risk bonds, and how to choose the right low risk bonds.

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What Are Low Risk Bonds?

Low risk bonds are fixed income securities issued by entities having a strong credit rating (AAA-BBB) or those backed by sovereign guarantee. Their high credit rating or sovereign guarantee leads them to carry minimal default risk in terms of principal and interest repayments. Their regular interest payments also make them highly suitable for retirees and conservative investors.

The low risk associated with these bonds leads their issuers to offer lower yields than bonds carrying higher credit risk. This makes these bonds suitable for conservative investors seeking higher capital safety and income certainty than equities or riskier bonds.

Note that the low risk bonds are called so only because of their lower credit risk. Other risks associated with bond investing, such as interest rate risk, liquidity risk and market risk, are not considered while categorising bonds as low risk.

How to Buy Bonds through Paisabazaar?

Get up to 13.25% from bonds in 5 simple steps

Step 1: Login to your Paisabazaar account

Step 2: Select the Bonds

Step 3: Complete the KYC process

Step 4: Enter bank details

Step 5: Link your demat account

Types of Low Risk Bonds

Government Bonds

Central Government bonds are considered to be the safest among all investment instruments as these are backed by sovereign guarantee. While the state government bonds, also known as State Development Loans (SDL), do not carry an explicit sovereign guarantee, these are considered to carry quasi-sovereign status. The RBI directly monitors the interest and maturity payments of state government bonds and can also make the pay-outs on behalf of their issuer governments from the budgetary allocation of the central government. Governments issue bonds to finance various developmental projects or meet other budgetary or non-budgetary expenditures.

Some of the other types of government bonds available in India include Sovereign Green Bonds (SGrBs), RBI Floating Rate Savings Bonds (FRSBs), Inflation Indexed Bond (IIB) and Sovereign Gold Bonds (SGBs). Except for FRSBs, these bonds are listed on the stock exchange and thus, can be bought or sold through the secondary market.

Investment Grade Corporate Bonds

Corporate bonds carrying credit ratings of AAA to BBB are known as investment grade corporate bonds. While a credit rating of AAA refers to the highest degree of safety in terms of interest and principal repayment, BBB refers to a moderate degree of safety. These credit ratings are assigned by SEBI registered credit rating agencies like ICRA, CARE, CRISIL, etc, based on the issuer's financial health and their ability to make interest payments and repay the principal amount on time.

Municipal Bonds

Municipal bonds, also known as muni bonds, are issued by local governments or municipalities to finance various public projects. As per the SEBI (Issue and Listing of Municipal Debt Securities (ILMDS)) Regulations, a municipal body seeking to raise funds through municipal bonds must obtain a credit rating from at least one SEBI-registered agency like CRISIL, ICRA, CARE, India Ratings, etc. The same regulations also require municipal bonds to be listed on at least one stock exchange.

According to SEBI statistics, 18 municipal corporations in India have issued municipal bonds in India since 2017. The coupon rates of bonds issued by these municipal corporations range from 7.15% to 10.23% with tenures ranging from 3 to 10 years. All the municipal bonds available for investment are rated AA by the credit rating agencies.

Low Risk Bonds with Tax Benefits

Capital Gain Bonds

Capital gain bonds allow their investors to claim a capital gain tax exemption by investing the profits arising from the sale of land or property. These bonds are also known as Section 54EC Bonds as the tax exemption is provided under Section 54EC of the Income Tax Act. However, the interest income earned from capital gain bonds is taxable as per the taxpayer’s income tax slab.

Capital gain bonds are issued by select public sector companies such as National Highway Authority of India (NHAI) and Rural Electrification Corporation (REC), which have been rated as ‘AAA’ by credit rating agencies like ICRA, CRISIL, etc These bonds offer fixed returns of 5.25% p.a. However, these bonds are not listed and thereby, cannot be traded in the secondary market.

Tax Free Bonds

Tax free bonds are issued by PSUs or government agencies and are also rated by credit rating agencies like CRISIL, CARE, etc. These bonds offer tax benefits under Section 10 of the Income Tax Act. The interest income earned from tax free bonds is exempt from income tax, helping investors in higher tax brackets retain more of their returns. These bonds can also be purchased or sold through the secondary market.

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Benefits of Investing in Low Risk Bonds

Higher Capital Safety: Low risk bonds ensure low default probability, as government bonds are backed by sovereign guarantee and other high rated corporate bonds have strong repayment capacity.
Higher Income Certainty: As these bonds are issued by governments or highly rated entities with a low probability of default, they ensure timely coupon payments and repayment of the principal at maturity.
Portfolio Stability: Low risk bonds reduce overall portfolio volatility and can act as a shield during poor market conditions and/or worsening economic situations.

Who Should Invest in Low Risk Bonds

Risk-averse investors who prefer a high degree of safety for their principal and interest receipts.
Retirees or conservative investors seeking regular and reliable interest income.
Investors seeking diversification to mitigate overall portfolio risk during uncertain market cycles.
First-time bond investors preferring safer fixed-income options.

How to Choose the Right Low Risk Bond

Check the credit rating of the issuer to filter out riskier bond options. Opt for government bonds or AAA-BBB rated corporate and municipal bonds.
Check the bond issuer’s financials, such as P&L account, leverage ratios, balance sheet, etc., to evaluate low risk bonds.
Check whether the bond is listed and actively traded on exchanges if you plan to exit before maturity.
Check the frequency of coupon payments before you start investing in a bond. Ensure that it matches your cash flow requirements.
Understand the tax implications of bonds before investing in them.
Evaluate Yield to Maturity (YTM) alongside the issuer’s credit rating. YTM is the annualised return earned if a bond is held till maturity. Bonds with lower credit ratings usually offer higher YTM to compensate for higher risk, whereas higher-rated bonds offer relatively lower YTM but safer returns. Thus, choose bonds that align with your risk appetite and risk-adjusted return expectations.

How to Buy Bonds through Paisabazaar?

Get up to 13.25% from bonds in 5 simple steps

Step 1: Login to your Paisabazaar account

Step 2: Select the Bonds

Step 3: Complete the KYC process

Step 4: Enter bank details

Step 5: Link your demat account

FAQs

The most common types of low risk bonds in India include investment grade corporate and municipal bonds (those rated from AAA to BBB), fixed rate central government bonds, state government bonds, sovereign gold bonds, floating rate bonds, capital gain bonds and tax free bonds.

The safety of a bond depends on factors such as the issuer’s credit rating, sovereign or government backing, financial strength of the issuer, etc.

AAA-rated corporate bonds generally offer higher yields than central government bonds. However, as AAA-rated bonds carry lower risk than other corporate/municipal bonds, the former usually offer lower yields than other categories.

Tax free bonds issued by PSU and other government entities carry low credit risk due to their higher credit rating and government ownership. These bonds are suitable for investors in the higher tax brackets tax free returns along with higher income certainty.

The lower residual maturity profile of short-term government bonds reduces the interest rate sensitivity of these bonds. This makes these bonds safer than government bonds having longer maturity profiles, especially during rising interest rate regimes.